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Companies with high amount of pledged promoter shareholding are susceptible to erosion in stock prices. The number of such companies has seen the highest quarterly jump in at least three years

A close look into the finances of companies is a must for stock market investors, especially at a time when there has been a rise in uncertainty, volatility and dynamics around rupee, while interest rates and liquidity are fast altering the financial position of companies. As fund raising for companies is becoming a challenge, pledging of shares by promoters has been on the rise. For the quarter ended June 2013, the percentage of promoter holding pledged witnessed the highest quarterly jump in at least three years — 11.4 per cent in March 2013 to 12.4 per cent in June 2013 — with a large number of companies witnessing a sharp rise in their promoters holding being pledged.

So as the environment opens up new challenges for the economy and the companies operating within the same, investors need to carefully analyse the companies before they enter them in search of high returns and fall into the valuation trap.

A look into the share prices of the companies with market capital of over Rs 1,000 crore and with significant rise in their promoters holding pledged over the previous quarter, shows a significant fall in their prices. While the Sensex fell by 6 per cent between January 1 and August 29, the share price of several of these companies fell by over 40 per cent in the same period.

Rise in share pledging

According to a report prepared by ICICIdirect based on shareholding data made public by 3,935 companies, over the last couple of years the percentage of promoters holding pledged has risen sharply from 9.4 per cent in June 2011 and has now gone up to 12.4 per cent. There has also been a significant rise in the percentage of total equity pledged in the system. While the pledged shares stood at 6 per cent of the total equity in March 2013, it has gone up to 6.6 per cent in just one quarter.

While there are various sources that companies and their promoters adopt to raise funds for their business needs or their personal needs, pledging of shares is one such source that gained prominence. Promoters in this method pledge their shares with lenders in the market to meet their requirement.